Earnings Report /
Sri Lanka

Nestle Lanka: Another slow year for volumes; some upside to margins

  • Demand recovery in CY 20e, albeit at a slow pace

  • Margin improvement on the way aided by stable FX and raw material prices

  • We revise our target price down to LKR 1,255/share and maintain our Hold rating

Asia Securities
4 March 2020
Published byAsia Securities

We revise our target price to LKR 1,255/share (previously LKR 1,335/share). Including a CY20E dividend of LKR 47.00/share, we derive a total return of +8.6%. HOLD. NEST reported a 4Q CY19 recurring net profit of LKR 717mn (-17.2% YoY). Topline was up just 1.1% YoY affected by adverse weather conditions during the first half of the quarter. As a result, EBIT margins declined by 2.5pp YoY to 11.0%. Interest costs on the other hand declined as NEST paid down a part of its short-term debt. Looking forward at CY20E, we expect continued pressure on demand as local brands remain aggressive and take share. However, on a positive note, with the FX impact moderating in 4Q CY19, we expect gross margins to improve on the back of a stable currency and raw material prices. Also, with short-term debt partly paid down, we expect interest expenses to decline going forward.

Demand recovery in CY20E, albeit at a slow pace

Topline was up just 1.1% YoY in 4Q CY19. Adverse weather conditions during October and November hurt demand while some of it was offset by better demand in December. As always, key brands such as Milo, Maggi and Nestomalt drove demand in late 4Q. With a number of consumer-friendly policies in place, we expect better demand recovery in 1H CY20E for NEST, albeit at a slow pace as local brand competition continues to remain strong. We also show some caution as we head into April which will see prolonged school holidays due to elections which will reduce demand for products such as Milo and Maggie noodles. Also, given the festive period, we expect families to travel more and dine out during the month which could lead to lower demand for seasoning products and coconut milk powder. We saw similar trends in May/June 2019 with prolonged school closures post-Easter attacks. Overall, we expect mid-single-digit topline growth for CY20E.

Margin improvement on the way aided by stable FX and raw material prices

As expected, 4Q saw the FX impact on raw material costs wearing off resulting in a lower gross margin contraction in 2H compared to 1H. However, with lower topline growth, EBIT margins declined by 2.5pp YoY to 11.0%. Looking forward, with the FX impact moderating in 4Q CY19, we expect gross margins to improve on the back of a stable currency and raw materials. On raw materials, our latest channel checks reveal that coconut yields are expected to pick up from April onwards aided by the rains during the latter part of CY 2019. As a result, we expect coconut prices to remain relatively stable till late-2H CY20E. However, fresh milk prices are expected to see a uptick due to high demand. Overall, we expect EBIT margins to improve by around 100bps in CY20E. On borrowings, NEST paid down a further LKR 240mn in short-term debt in 4Q CY19, which will lead to lower interest costs in CY20E, aiding the bottom-line.

We revise our target price to LKR 1,255/share and maintain our HOLD rating

The stock is down 7.7% YTD and down 29.4% YoY, and is currently trading at 20.3x CY20E EPS, in line with the 3-yr historical trading average. As we roll over our valuations to CY20E and including our revisions to estimates, we revise our target price to LKR 1,255/share (previously LKR 1,335/share). With a CY20E dividend of LKR 47.00/share, we derive a total return of +8.6%. HOLD.